Mikesell Revising Bretton Woods 1996

PPB No.
24
2/17/99
3:13 PM
Page a1
The Jerome Levy Economics Institute of Bard College
Public Policy Brief

Revisiting Bretton Woods
Proposals for Reforming the International

Monetary Institutions
Raymond F. Mikesell
No. 24/1996
PPB No.24
2/17/99
3:13 PM
Page 2
The Jerome Levy Economics Institute of Bard

College, founded in 1986, is an autonomous, independently endowed re s e a rch organization. It is
nonpartisan, open to the examination of diverse
points of view, and dedicated to public service.
The Jerome Levy Economics Institute is publish ing this proposal with the conviction that it repre sents a constructive and positive contribution to
the discussions and debates on the relevant policy
issues. Neither the Institutes Board of Governors
nor its Advisory Board necessarily endorses the
proposal in this issue.
The Levy Institute believes in the potential for the
study of economics to improve the human condition. Through scholarship and economic forecasting it generates viable, effective public policy
responses to important economic problems that
profoundly affect the quality of life in the United
States and abroad.
The present research agenda includes such issues as
financial instability, poverty, employment, problems associated with the distribution of income and
wealth, and international trade and competitiveness. In all its endeavors, the Levy Institute places
heavy emphasis on the values of personal freedom
and justice.
Editor: Sanjay Mongia

Associate Editors: Theresa Ford and Frances M. Spring
The Public Policy Brief Series is a publication of The Jerome Levy Economics Institute of Bard College,
Blithewood, Annandale-on-Hudson, NY 12504-5000, 914-758-7700, 202-737-5389 (in Washington, D.C.),
e-mail info@levy.org.
The Public Policy Brief Series is produced by the Bard Publications Office.
Copyright 1996 by The Jerome Levy Economics Institute. All rights reserved. No part of this publication may
be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying,
recording, or any information-retrieval system, without permission in writing from the publisher.
ISSN 1063-5297
ISBN 0-941276-15-5
PPB No.24
2/17/99
3:13 PM
Page 3
Summary
The year 1994 was the fiftieth anniversary of the signing at Bretton
Wo ods, New Hampshire, of the Articles of Agreement of the
International Monetary Fund (IMF) and the World Bank. Many
addresses at anniversary celebrations praised the contributions of the
IMF and World Bank, but they were overshadowed by the widely
held conviction that both institutions are seriously in need of overhauling. However, there is no consensus on how they should be
changed. Some analysts believe that one or both have outlived their
usefulness and should be abolished, while others believe that they
should continue to operate, but with new responsibilities, new organization, and enhanced resources.
Underlying the proposals to alter or abolish these institutions is the
belief that neither is able to deal with the worlds current economic
problems. The IMF has had virtually no influence on the international monetary system since the early 1970s, nor has it had a laudable re c o rd in promoting balance of payments equilibrium and
financial stability in the developing countries. The World Bank has
fallen short of achieving its primary goals of reducing world poverty
and putting the worlds poorest countries on the path to sustainable
development.
In this Public Policy Brief, Raymond F. Mikesell outlines the original
goals of the IMF and World Bank and the activities they have
assumed as they evolved and evaluates the success of the institutions
in meeting both past and subsequent goals. He analyzes the current
debate about whether the IMF should play a more active role in
managing the international monetary system, in managing currency
crises (such as the one recently experienced in Mexico), and in providing credit to newly capitalist countries. Mikesell examines proposals that the World Bank do more to promote private investment
in developing countries, make more loans for expanding social and
economic objectives (such as reducing poverty, promoting greater
equality of opport u n i t y, improving health and education, and
maintaining the environment), and improve the efficiency of its
operations.
PPB No.24
2/17/99
3:13 PM
Page 4
Mikesell cautions that he cannot state his conclusions with unequivocal conviction or passion; the issues are too complex, the arguments
on both sides of the debate too persuasive, and the reputations of the
debators too impressive. Given the large financial resources and the
highly competent staffs of the IMF and World Bank, Mikesell feels
that the two institutions should be doing a better job promoting trade
and reducing poverty. However, because there is general agreement
that there is a need for multilateral institutions to promote world
trade and reduce world poverty, he feels that abolishing the institutions is not an appropriate response. Rather, he recommends that
(1) the World Bank Group and IMF should be merged to form a single
organization, the World Bank and Fund Group (WBFG), with one
executive director for both institutions; (2) neither the IMF nor the
WBG should be given responsibility for establishing and managing an
exchange rate target zone system or for stabilizing the exchange rates
of the major currencies; (3) the establishment of additional institutional constructs to deal with financial crises should be deferred; (4)
the WBG should move rapidly to change the composition of its lending by making fewer loans to governments and state enterprises and
increasing its loans to the private sector, including nongovernmental,
nonprofit entities; and (5) the WBG should be gradually downsized by
reducing the number of countries eligible for loans.
PPB No.24
2/17/99
3:13 PM
Page 5
Contents
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Preface
Dimitri B. Papadimitriou . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Proposals for Reforming the International Monetary Institutions
Raymond F. Mikesell . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
About the Author . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40
PPB No.24
2/17/99
3:13 PM
Page 7
Preface
The fiftieth anniversary of the 1944 Bretton Woods agreement caused
many to reflect on the structure of the international monetary system and
the usefulness of the institutions created by the agreement. Some, including former chairman of the Federal Reserve Paul Volcker, have called for
the return to a managed monetary system in which exchange rates are
not allowed to float freely, but are held within a set range of rates.
An argument for managing rates is that it would reduce the volatility of
exchange rate movements, a volatility that introduces uncertainty into
global economic decision making. Those who argue in favor of maintaining
the current floating rate system assert that even if an appropriate range of
rates could be determined and could be agreed upon by the leading industrialized nations, the size of currency interventions necessary to affect those
rates is too large (relative to total market activity) for central banks to
undertake. Moreover, in order to maintain exchange rates within a given
band of values, central banks might have to sacrifice some freedom in their
use of monetary and fiscal policies to achieve domestic objectives. Another
issue is determining who would have oversight powers in such a system.
Some propose that the International Monetary Fund (IMF) be more
active in the international monetary system, managing currency crises
and providing credit to newly capitalist countries. Others, however, note
that it has had virtually no influence on the international monetary system since the 1970s and its record in promoting balance of payments
equilibrium and financial stability in developing countries is not laudable. According to such critics, the IMF should be abolished or at least its
functions should be reduced or combined with those of the World Bank.
The Jerome Levy Economics Institute of Bard College 7
PPB No.24
2/17/99
3:13 PM
Page 8
In this Public Policy Brief Raymond F. Mikesell analyzes the merits of these
arguments, reviews the success of the institutions in accomplishing their
original functions, describes other roles they have performed, and makes
recommendations for reform. He notes that the IMFs functions changed
after the 1970s, when the Bretton Woods par value system broke down
and exchange rates were allowed to float. He proposes that, because
some of the IMFs operations overlap those of the World Bank, the two
institutions should be combined. One area of overlap is aid to Eastern
European countries to assist them in the transformation to market-based
economies. Mikesell notes, the IMFs functions in these countries are
not only far removed from those for which it was designed, but there is
little to distinguish IMF eff o rts from those of the World Bank.
Moreover, the IMFs lending programs in Russia and some other newly
capitalist countries have not been successful in promoting their transition to capitalism or improving their balance of payments.
There is a question of whether aid to the Eastern European countries to
develop a capitalist economy should be provided by the IMF and the
World Bank or directly by the governments of the Western industrialized
nations. IMF loans are supposed to be conditional upon a countrys success
in changing the economic and political structure of its economy. However,
the decision as to whether to grant a loan may be difficult for an international agency. This difficulty is best illustrated by the politics surrounding
the approval of the pending $9 billion loan by the IMF to Russia.
Although some economic progress (lower inflation and stabilization of the
ruble within a narrow range) was seen in Russia during 1995, political
changes have led to uncertainties about the direction of future market
reforms. A refusal to grant the loan, based on these economic considerations alone, would be seen as a vote against the Russian leaders ability to
pursue market reforms and could cripple the Russian economy. Moreover,
President Clinton has urged the IMF to approve the loan. If the United
States and other Western nations feel that factors other than economic
changes must be considered, it might be best, as some have suggested, that
the loans be made directly by those governments. Mikesells insights into
these issues can serve as a basis for discussion of international monetary
problems.
Dimitri B. Papadimitriou, Executive Director
February 1996
8 Public Policy Brief
PPB No.24
2/17/99
3:13 PM
Page 9
Proposals for Reforming the

International Monetary Institutions
The year 1994 was the fiftieth anniversary of the signing in Bretton
Wo ods, New Hampshire, of the Articles of Agreement of the
International Monetary Fund (IMF) and the World Bank. The anniversary was celebrated at meetings in Washington, D.C., Bretton Woods,
and Madrid.1 As one of the few surviving participants of the Bretton
Woods conference, I was privileged to attend the first two commemorations. The many addresses at the 1994 meetings praising the contributions of the IMF and the World Bank were overshadowed by the widely
held conviction that both institutions are seriously in need of overhauling. However, there is no consensus on how they should be changed.
Some analysts believe that one or both have outlived their usefulness
and should be abolished, while others believe that they should continue
to operate, but with new responsibilities, new organization, and
enhanced resources.
Underlying the proposals to alter or abolish these institutions is the
belief that neither is able to deal with the worlds current economic
problems. There is great dissatisfaction with the present international
monetary system. The IMF has had virtually no influence on the system
since the early 1970s, nor has it had a laudable record in promoting balance of payments equilibrium and financial stability in the developing
countries. The World Bank has fallen short of its primary goals of
reducing world poverty and putting the worlds poorest countries on the
path to sustainable development.
PPB No.24
2/17/99
3:13 PM
Page 10
The World Financial System after Bretton Woods

The IMF and the World Bank were designed to help avoid the chaotic
financial conditions that prevailed during the 1930s and to facilitate the
transition to a postWorld War II economy that would be characterized
by stable exchange rates, the absence of exchange restrictions on trade,
and readily available capital for financing postwar reconstruction and
the development of poor countries. Under the 1944 agreement the IMF
was expected to promote a new international monetary order by establishing and enforcing rules governing exchange rates and fore i g n
exchange transactions and by providing assistance to help countries con form to these rules; the World Bank was expected to help reduce world
poverty and to assist in economic development by promoting private and
public capital flows into developing countries.
Owing to the magnitude of the financial requirements for reconstruction
and to the balance of payments problems of the European countries, neither the IMF nor the World Bank played a significant role during the
immediate postwar period. The Marshall Plan provided most of the
financing for European recovery, while the European Payments Union
(EPU) established a payments system that permitted multilateral intraEuropean trade and paved the way for the operation of the IMF par value
system based on the gold-convertible dollar implemented in the 1960s.2
By the end of the 1960s the principal threat to the par value system was the
weakness of the dollar itself. Worldwide economic recovery brought about a
change in trade patterns and capital markets resulting in the replacement of
the dollar shortage of the 1950s with a dollar surplus in the late 1960s. The
termination of dollar convertibility into gold in 1971 and the abandonment
of efforts to maintain fixed exchange rates by the major countries in 1973 left
the IMF with little influence on the international monetary system. The
Bretton Woods monetary system was dead, and few expected it to be revived.
The IMF found its niche in providing advice and making loans to developing countries under a variety of programs. These loans had little to do
with exchange rate stability; in fact, the preloan agreements often
re q u i red devaluation along with trade and exchange liberalization.
Although some of the loans assisted countries during crises resulting
from sudden declines in export income, most were designed to induce
PPB No.24
2/17/99
3:13 PM
Page 11
countries to reform those economic policies that had contributed to balance of payments disequilibrium.
Since it began operations in 1946, the World Bank has been almost
completely occupied with assistance to developing countries. Although
the World Banks charter emphasized its role in promoting the flow of
private capital, the bulk of its loans have been made to governments.
During the 1950s lending by the World Bank was hampered by a shortage of projects that met the standards of commercial bank loans as interpreted by successive World Bank presidents, all of whom, except for
Robert McNamara, were products of the American banking community.
In the beginning most World Bank loans were for specific infrastructure
projects such as large dams, power, and transportation, but the idea
slowly emerged that the World Bank should be a development institution concerned with social welfare and eliminating poverty.
The lending capacities of both the IMF and the World Bank increased
steadily from their inauguration in 1946. By the end of fiscal year (FY)
1994 outstanding credits provided by the IMF totaled about $45 billion. In
addition, the IMF has allocated to its members 21 billion special drawing
rights (SDRs), which the members can use to buy the currencies of other
members.3 Most of the increases in the IMFs resources have occurred with
periodic increases in member quotas, determining both the capital subscriptions to the IMF and how much members can normally borrow.
World Bank loans outstanding at the end of FY 1994 totaled $109 billion, with annual loans averaging $14 to $17 billion annually between
FY 1990 and FY 1994. The World Bank also manages an associate organization, the International Development Association (IDA), which
loaned about $6.6 billion in 1994. Another World Bank associate, the
International Finance Corporation (IFC), provides equity and debt
financing to private enterprise in developing countries; in FY 1994 it
committed $2.5 billion. A third associate, the Multilateral Investment
Guarantee Agency (MIGA), promotes foreign direct investment in
developing countries by offering political risk investment insurance.
Together these four institutions make up the World Bank Gro u p
(WBG). The World Bank and the IDA operate under the same management, but with different sources of funding. The IFC and the MIGA
have both separate managements and separate sources of funding.
PPB No.24
2/17/99
3:13 PM
Page 12
Alternative International Monetary Systems

The major proposals for changing the functions and organization of the
IMF relate to its role in the international monetary system. One proposal
is to give the IMF an important function in remodeling the international
monetary system. A counterproposal is to merge the IMF and the World
Bank because the IMF no longer plays a significant role in the international monetary system, and its assistance to developing countries duplicates the activities of the World Bank. The analysis of altern a t i v e
international monetary systems in the following paragraphs provides a
basis for evaluating these contrasting proposals.4
Managed Versus Floating Exchange Rates

Prior to World War I the gold standard provided a system of fixed
exchange rates and automatic balance of payments adjustment by allowing gold movements to affect the money supply. During World War I
most countries went on a managed currency system and several, including the United Kingdom and France, returned to a gold parity system in
the 1920s. In the 1930s exchange rates were neither fixed nor freely
floating, but were managed in a way that resulted in restricted and discriminatory trade. The United Kingdom abandoned the gold standard in
1931. In 1933 the dollar was allowed to float, but the United States
went back on the gold convertible standard in early 1934. The Bretton
Woods system of fixed but adjustable parities was a compromise between
the gold standard and a managed system. Following the breakdown of
the Bretton Woods par value system in the early 1970s, the major currencies were allowed to float with occasional attempts to manage them,
a condition that continues to exist today.
There is substantial dissatisfaction with the current floating rate system.
There have been large swings in exchange rates between major currencies,
but these fluctuations have not promoted a satisfactory pattern of current
account balances. In particular, there has been dissatisfaction with trade
balances, which make up a substantial proportion of current account balances.5 The fluctuations in exchange rates have occurred largely as a consequence of capital movements generated by interest rate differentials
among the countries, cyclical movements in national business conditions,
PPB No.24
2/17/99
3:13 PM
Page 13
and currency speculation. Freely fluctuating rates, with no attempt on the

part of the central banks to influence them, are equilibrium rates in the
sense that demand for and the supply of foreign exchange from all sources
are equal, but such equilibrium rates may not be compatible with the current account balances that governments desire. For example, Japan may
want a large trade surplus, but the United States and European countries
may not want trade deficits. What governments would like to have is a
combination of (1) equilibrium rates, (2) satisfactory current account balances, and (3) relatively stable rates. The controversy over managed versus
freely floating rates is a controversy over which system will most closely
approximate these conditions.
Milton Friedman (1953) has argued for half a century that exchange rates
should be determined in free markets with no attempt to control them.
Exchange rates determined in free markets will always be equilibrium rates,
and if governments prevent inflation by properly controlling the supply of
money, exchange rate fluctuations will be moderate. Friedmans position is
echoed by many leading economists today. For example, in his address to
the annual meeting of the American Economic Association in January
1995, George P. Schultz (former secretary of state and former University of
Chicago professor of economics) stated that We should stop worrying
about the exchange system. We now have a dirty float. . . . The system
would work better if it were cleaner, that is, with less government intervention. But the system does in fact work reasonably well and has done so over
a twenty-year period during which the system has experienced and
absorbed some tumultuous economic changes (Schultz 1995, 3).
The argument for managing exchange rates is that a freely floating rate
system results in wide exchange rate fluctuations, which do not contribute to orderly balance of payments adjustments and may impair
trade. Central banks can stabilize exchange rates to those approximating
equilibrium over the intermediate run and can alter them when fundamental economic conditions render such rates incompatible with equilibrium. If a country has a trade or current account deficit, the central
bank can adjust the exchange rate to reduce or eliminate the deficit.
Thus, managed rates provide a means of adjusting the trade or current
account, while freely fluctuating rates, which respond to speculative and
other temporary forces, may at times be inappropriate for achieving the
desired trade or current account balance. A change in the exchange rate
PPB No.24
2/17/99
3:13 PM
Page 14
will affect the trade balance by changing the relationship between

domestic and foreign prices of a countrys exports and imports. For example, if Mexico reduces the value of the peso in terms of the dollar, peso
prices of U.S. goods will rise, so that Mexicans will buy less from the
United States. In addition, the dollar will buy more pesos, so that the
prices of Mexican goods to U.S. consumers will decline and Mexico will
sell more goods to the United States.
There are, however, some problems with this analysis. First, relative
prices of many internationally traded goods do not immediately adjust to
changes in exchange rates. If the U.S. dollar were to depreciate by 10
percent in terms of a composite of all foreign currencies, the dollar prices
of imports would not immediately rise by 10 percent because some foreign suppliers in competition with domestic producers would not raise
their U.S. prices by that amount. And some U.S. exporters would raise
their dollar prices to maintain the foreign currency prices of their
exports. Second, even when prices are adjusted to reflect a change in the
exchange value of a currency, consumers are often sluggish in shifting
purchases from foreign to domestic sources. Because of these two factors,
the immediate effect of a currency depreciation may be to worsen the
trade balance for a few months, after which improvement may take place
gradually over a couple of years. This initial worsening of the trade balance after depreciation followed by a gradual improvement over time is
sometimes called the J-curve effect (Krugman 1991, ch. 2).
A third reason why changing the exchange rate may not improve the
current account balance relates to macroeconomic conditions. If a countrys current account balance is to improve, there must be an increase in
that countrys total output relative to its total expenditures on consumption and investment. The current account balance must always equal the
difference between national output and total expenditures. This identity
may be expressed as
CA = Y (C + I) G
where CA is the current account, Y is national output, C is private consumption, I is private domestic investment, and G is government spending.6 In order to improve the current account, there must be an increase
in Y, a decrease in domestic expenditures (C + I + G) with more of the
PPB No.24
2/17/99
3:13 PM
Page 15
output going into exports, or some combination of both. This will take
place only if depreciation is accompanied by the appropriate macroeconomic adjustments, but appreciation alone will not automatically produce these adjustments. If depreciation stimulates inflation, domestic
expenditures may rise relative to output. Also, inflation may nullify the
effects of depreciation on the increase in import prices relative to the
prices of domestic goods and on the decrease in export prices in terms of
foreign currencies so that the trade balance will not improve. Under
these conditions, currency depreciation may fail to improve the current
account balance (Mikesell 1995, 1215). For example, the U.S. current
account deficit was $7 billion in 1991 and $68 billion in 1992, but rose
to over $100 billion in both 1993 and 1994, despite a more than 40 percent decline in the value of the dollar in terms of the Japanese yen
between 1990 and 1994 and a somewhat smaller depreciation of the dollar in terms of the German mark.
Other factorssuch as a rise in private investment, a decline in personal
saving, and a substantial budget deficitcontributed to the current
account deficit. Over the long run a countrys trade and current account
balances will respond to a change in the real exchange rate (the nominal
rate adjusted for relative changes in domestic versus foreign prices), but
over the intermediate run the balance may be affected by a variety of
macroeconomic factors.
Some analysts doubt the ability of central bankers and finance ministers to
identify equilibrium exchange rates or to know how far rates ought to
change to restore balance of payments equilibrium (for example, Krugman
1990, ch. 14.) With open capital markets and instant information about
economic conditions affecting securities markets and interest rates,
exchange markets react to changes in fundamental conditions that may
affect the balance of payments almost as soon as the research staffs of central banks and finance ministries process the information. By the time governments get around to making policy changes, a substantial capital
movement may have already occurred. An anticipated depreciation may
result in massive capital flight, while an anticipated currency appreciation
may induce inward capital movements and further appreciation accompanied by a larger current account deficit. These conditions greatly complicate the problem of setting target rates that are both consistent with
equilibrium and likely to remain stable. Those who favor freely floating
PPB No.24
2/17/99
3:13 PM
Page 16
rates argue that by allowing rates to be determined in the market, the rates
will always be at the equilibrium level, and sudden large changes in rates,
which may occur under a managed rate system, are more harmful to trade
and investment than small movements under a fully floating system.
Instruments for Managing Exchange Rates

The principal instruments for managing exchange rates are (1) central
bank intervention in the exchange market, (2) changes in short-term
interest rates, and (3) fiscal policy. The first two are usually controlled by
central banks, while fiscal policy is controlled by governments, both the
administration and the legislature. Central banks do attempt to affect
exchange rates with the instruments at their disposal, but governments
rarely attempt to affect exchange rates with fiscal policy.
Central bank intervention in the exchange market is of two types: sterilized and unsterilized. In unsterilized intervention, purchases of foreign
currencies on exchange markets with domestic currency or purchases of
domestic currency with foreign exchange are allowed to have their full
impact on the countrys bank reserves and, therefore, on interest rates
and quantity of money. However, most intervention is sterilized; that is,
the effect of exchange market activity on the money supply is offset by
central banks through open market operations. The record of success of
sterilized intervention in keeping exchange rates within an agreed range
is poor (Humpage 1993, 216; Obstfeld 1990, ch. 5). Although intervention serves as a signal to the market of the official view of the government on exchange rate policy, the volume of intervention tends to be
too small in relation to total market activity to affect the rate substantially. For example, in the period from January to March 1995, during
which the dollar was under substantial downward pressure, U.S. monetary authorities intervened in the total amount of $1.42 billion against
the deutsche mark and the yen; nevertheless, the exchange value of the
dollar continued to decline in terms of these currencies. In early March
1995 the Federal Reserve, in collaboration with a number of European
central banks, intervened to support the dollar; the Fed purchased $450
million against the deutsche mark and $370 million against the yen.
According to a report published by the Federal Reserve Bank of New
PPB No.24
2/17/99
3:13 PM
Page 17
York (1995), The dollar met aggressive selling by market participants

and proceeded to trade progressively lower. Such small interventions
cannot have much effect on a world currency market with daily transactions currently exceeding $1 trillion. A truly massive intervention could
almost certainly stabilize the dollar for a time, but could prove costly if
the stabilized rate proved to be untenable.
Short-term interest rates are sometimes increased by central banks in order
to support the exchange value of a currency. The German Bundesbank cut
its discount rate from 4.5 percent to 4.0 percent on March 30, 1995, to support the dollar (Federal Reserve Bank of New York 1995, 9). A similar
reduction taken at the same time by the Bank of Japan was probably for the
same reason. There is little indication that recent U.S. Federal Reserve
interest rate policy has been motivated by a desire to support the dollar.7
International Coordination to Manage Exchange Rates

Efforts to manage exchange rates are likely to be more successful when
several countries coordinate their policies than when a country acts
alone. Assuming the major economic powers were to reach an agreement on a set of desirable exchange rates, they could coordinate their
monetary and fiscal policies and central bank operations in an effort to
s u p p o rt these rates or to maintain them within a specified range.
Countries with strong currencies would reduce their short-term interest
rates and their budget surpluses, while countries with weak currencies
would increase their interest rates and eliminate their budget deficits.
But such measures might well be in conflict with the domestic objectives
of the countries trying to coordinate.
Monetary and fiscal coordination is provided in the Maastricht Treaty
(signed by the members of the European Union, or EU), which looks
t o w a rd the establishment of a European Monetary Union (EMU).
However, coordination is much more difficult for countries outside the
EU because they do not have the same arrangements for mutual assistance or the common political and economic goal of monetary union.
Coordinating financial policies in the interest of stabilizing exchange
rates raises the question of whether and to what extent nations should
PPB No.24
2/17/99
3:13 PM
Page 18
compromise their domestic objectives by such coordination. Are the

gains from exchange rate stabilization worth the sacrifice of domestic
objectives? Empirical evidence is not conclusive and most governments
do not favor sacrificing domestic objectives to promote exchange rate
stability. This has been an issue even in efforts to form the EMU. Some
countries, notably France and Germany, seem willing to subordinate
domestic objectives to achieve permanently fixed exchange rates and a
common currency, but the United Kingdom has been unwilling to do so.
Proposals for Changing the Functions and Organization

of the IMF
Traditional Role of the IMF

The traditional purpose of IMF assistance has been to help countries
achieve balance of payments equilibrium without resorting to trade or
exchange restrictions on imports of goods or services, defaulting on
international debt, budgetary actions falling heavily on the poor, or
reducing investments important to economic growth. Over the past
decade the IMF introduced two new loan facilities that differ from its
traditional assistance. One is the structural adjustment facility (SAF),
which provides loans on very liberal termsan interest rate of only 0.5
percent and repayments over 5 1/2 to 10 yearsin support of macroeconomic reforms and structural adjustments. SAF loans are accompanied
by detailed agreements on programs that the borrowing country may
engage in, such as the allocation of domestic credits, the privatization of
state enterprises, price controls, and trade regulations, all of which go
beyond the usual macroeconomic adjustments.
Not all of the SAFs have succeeded in achieving balance of payments
improvement and satisfactory economic growth. There have been several outright failures, especially in the African countries, notably Zambia
and Zaire. In some of these countries economic pro g ress has been
impaired by civil wars and irresponsible dictators. As of FY 1994, IMF
obligations in arrears totaled 2.9 billion SDRs ($4.3 billion). Many
PPB No.24
2/17/99
3:13 PM
Page 19
countries would probably default on their repurchase agreements to the

IMF if they could not continue to receive new loans. Hence, repayments
are not being made from improvements in the balance of payments.
According to Peter Kenen (1994a, 34), It is time to concede that the
[ I n t e rnational Monetary] Fund and the [World] Bank have been
involved in the de facto rescheduling of their claims on a number of
developing countries that cannot possibly repay them. Assistance from
the IMF has undoubtedly helped some countries, such as Korea, liberalize their economies and achieve reasonable growth rates. On the other
hand, it may be argued that the absence of financial assistance from the
IMF might force countries to institute economic reforms more rapidly
and avoid accumulating external indebtedness.
The second IMF facility, the systemic transformation facility, was created in 1993 to assist former Soviet countries with transforming their
economies to private enterprise and free markets. Such assistance
involves problems quite different from those in most developing countries, in which private economies with established markets, credit institutions, and reasonably functioning systems of monetary control already
exist. An IMF task in assisting the former Soviet countries has been to
formulate national plans for establishing new financial institutions to
mobilize and allocate credit and for creating the capital markets required
for transferring ownership from the state to the private sector. The IMFs
functions in these countries are not only far removed from those for
which it was designed, but there is little to distinguish IMF efforts from
those of the World Bank, which is operating in the same countries.
The IMFs lending programs in Russia and some other newly capitalist
countries have not been successful in promoting their transition to
capitalism or improving their balance of payments. Privatization has
been slow and trade has fallen sharply, partly as a result of the collapse
of ruble-based trade and the shortage of foreign exchange to finance
trade (Black 1994, 265272). However, since chaotic political and
social conditions seem to have been the major barriers to a smooth
transition, such a transition may perhaps be more a political than an
economic matter. Therefore, it might be argued that coordinated assistance from the NATO countries is more appropriate than IMF (or
World Bank) assistance.
PPB No.24
2/17/99
3:13 PM
Page 20
Exchange Rate Management as a Multilateral Effort

Proposals for giving the IMF a more active role in the international
monetary system involve the question of whether exchange rate management should be a multilateral effort. Every countrys exchange rate is,
by definition, of concern to its major trading partners. Attempts to stabilize or otherwise control an exchange rate require international cooperation, since the action of an individual country to lower the exchange
value of its currency could be countered by other countries.
If there is to be multilateral action to control exchange rates, the selection
of any exchange rate to be maintained or kept within a particular range
should be made within the context of an agreed upon pattern of rates of all
major currencies. Moreover, the agreed pattern must take into account the
pattern of current account balances with which the rates must be consistent. For example, the United States has expressed dissatisfaction with its
large bilateral deficit with Japan, but if this deficit is to be reduced within a
system of managed rates, Japan will have to reduce its overall bilateral current account surplus or shift that surplus to developing countries by
exporting more capital to them. Those who argue for a multilateral
agreement on stabilizing exchange rates must take into account the negotiating problems involved in reaching a consensus on the pattern of current account balances and the willingness of the countries to adopt
monetary, fiscal, and other policies consistent with the agreement.
The IMFs Role in a New International Monetary System

The two most frequently discussed proposals for an active role by the
IMF in reforming the international monetary system are the proposals of
the Bretton Woods Commission and the target zone system put forth by
economists associated with the Institute for International Economics
(Williamson and Miller 1987, Williamson and Henning 1994, Bergsten
and Williamson 1994). According to the Bretton Woods Commission
re p o rt (1994b, A45), (1) The major industrial countries should
strengthen their fiscal and monetary policies and achieve greater overall
macroeconomic convergence; (2) these countries should establish a
more formal system of coordination, involving firm and credible commitments, to support these policy improvements and avoid excessive
PPB No.24
2/17/99
3:13 PM
Page 21
exchange rate misalignments and volatility; and (3) the IMF should be
given a central role in coordinating macroeconomic policies and in
developing and implementing monetary reform.
The re p o rt suggests that the G-7 countries should grant operating
authority to the IMF for stabilizing exchange rates. However, the report
is vague regarding the nature and implementation of the new international monetary system; it merely recommends that the system should
promote exchange rate stability and avoid misaligned rates. Without formally endorsing a target zone system, the report appears to favor allowing some flexibility in exchange rates rather than fixing rates at
particular levels. It states that the G-7 countries would need to negotiate
agreements among one another as to their obligations for promoting
exchange rate stability, but the report does not say how agreements
would be reached on the pattern of rates to be stabilized. Presumably, an
important function of the IMF would be to prepare a detailed plan for
approval by the G-7 countries.
A c c o rding to the target zone system outlined by Williamson and
Henning (1994), exchange rates would be maintained within a zone of
fluctuation based on fundamental equilibrium exchange rates (FEERs).8
The FEERs would be consistent with the current account balance of
each country and with its domestic objectives of full employment and
price stability. The finance ministers and central bank managers of the
G-7 countries would be at the center of international monetary management. The IMF would provide the secretariat and the forum in
which the ministers of the G-7 countries would meet to make basic policy decisions. The G-7 countries would set targets for the curre n t
account balances of the participants in the target zone regime, identify
the FEERs, and establish pro c e d u res for realigning target zones in
response to developments calling for balance of payments adjustments
(Williamson and Henning 1994, 104). The IMF would have the power
of surveillance over the exchange policies of its members. However, it
would be a council of G-7 finance ministers that would establish the target zones for the exchange rates and determine the changes in monetary
and fiscal policies needed to sustain them.
Supporters of the target zone system apparently assume that the band within which exchange rates fluctuate will be wide enough to accommodate
PPB No.24
2/17/99
3:13 PM
Page 22
pressures arising from speculative capital movements and that such capital
movements will tend to reverse when an exchange rate approaches either
end of the band. One problem with this assumption is the difficulty of
defining the width of the band. A wide band, say, 20 percent, would contribute little to reducing exchange rate fluctuations; a narrow band would
make it more difficult to maintain rates within the zone. There is also the
question of how frequently and under what conditions the band would be
changed. If the band is not changed quickly after the market perceives that
fundamental conditions are inconsistent with maintaining rates within the
band, the resulting large capital movements would require large offsetting
interventions. On the other hand, if the band is changed frequently, the
system will lose credibility and there will be little exchange rate stability
(Kenen 1994a).
Opposition to a substantial role for the IMF in a new international monetary system has been expressed by both economists and government
officials (Mikesell 1995, 2628). Most of the opposition concerns the
desirability or feasibility of managing exchange rates, either unilaterally
or multilaterally. One objection is that exchange rate management is
likely to be more harmful than beneficial because governments will tend
to support improper (disequilibrium) exchange rates or will continue to
support rates long after fundamental conditions change. A second objection is that the cost of the loss of freedom to use monetary and fiscal
policies for promoting domestic objectives outweighs any possible benefits of currency stabilization. Some doubt that currency fluctuations significantly impede trade since the cost of hedging contracts in foreign
currencies is relatively small. A third objection is that neither the IMF
nor the G-7 countries will be able to determine FEERs accurately or to
recognize when conditions dictate a change in FEERs. A fourth objection is that central bank intervention cannot maintain exchange rates in
the face of large speculative capital movements. A fifth objection is that
it may not even be possible for the major countries to reach agreement
on the pattern of exchange rates they would support, either because the
rates may not be consistent with their trade objectives or because the
monetary and fiscal policies required to support the rates are inconsistent
with domestic economic objectives.
Representatives from the governments of major countries who attended
the 1994 Bretton Woods conference in Washington were not enthusiastic
PPB No.24
2/17/99
3:13 PM
Page 23
about either multilateral coordination or a dominant role for the IMF in

creating a new international monetary system. Larry Summers, currently
U.S. deputy secretary of the treasury, expressed doubts regarding the feasibility of policy convergence in light of the EU experience (Bretton
Woods Commission 1994a, 19). Kosuke Nakahira, the Japanese vice minister of finance for international affairs, also played down a future role for
the IMF, stating that What is important, in my view, is to have frequent
and informal contacts among policy makers, ministers of finance, and
central bank governors or their deputies, say, through G-7 meetings or
other appropriate forums, rather than to formalize or institutionalize the
coordination process (Bretton Woods Commission 1994a, 23). Gert
Haller, the representative of the German Federal Ministry of Finance,
rejected international coordination of monetary and fiscal policies and
target zones on both theoretical and policy grounds (Bretton Woods
Commission 1994a, 21).
Since the termination of the dollar convertibility into gold in 1971, the
U.S. government has had relatively little interest in stabilizing the foreign exchange value of the dollar, showing concern only when the dollar
depreciated sharply. During the first Reagan administration the Treasury
Department was against intervention in the exchange market and any
other action to reduce the value of the dollar, which in 1984 was generally regarded as substantially overvalued.9 When James Baker became
S e c re t a ry of the Tre a s u ry in January 1985, there was a shift in the
Treasury Departments position on the dollar. At a meeting of the G-5
countries at the Plaza Hotel in New York in September 1985, the U.S.
Treasury, in cooperation with the other G-5 governments, agreed to
reduce the external value of the dollar by means of intervention, and the
dollar depreciated from 1985 to 1987 (Obstfeld 1990). The Louvre
Accordan agreement among the G-7 countries on collective action to
stop the fall of the dollar and to stabilize G-7 currencies within reference
rangeswas reached in February 1987, but there was little willingness
on the part of the governments to change their monetary and fiscal policies (Obstfeld 1990). After rallying in 1988, the dollar resumed its
decline in 1989 and continued to fall during the first half of the 1990s.
Barry Eichengreen (1995) contends that there is no middle ground
between freely floating rates and a unified monetary system with a common currency, such as the EU is seeking to achieve. In his view, stabilizing
PPB No.24
2/17/99
3:13 PM
Page 24
exchange rates through policy coordination or convergence is not possible.

Monetary unification requires a high degree of political integration, which
seems far in the future, even for the EU countries. Richard Cooper (1994)
takes much the same position as Eichengreen in his criticism of the target
zone system. He suggests that in the long run, but not for the next few
years, we will desire irrevocably fixed exchange rates among the major currenciesin effect, a common currency among the industrialized democracies (Cooper 1994, 112116). Thus, we find a fundamental conflict in
the positions taken by leading international economists about the possibility of forming an international monetary system in which there is multinational coordination to stabilize exchange rates.
Without specific commitment by governments to support an exchange
rate stabilization program in which the IMF would play a major role, the
IMFs influence on the international monetary system is limited to
preparing financial analyses, carrying on formal annual consultations
with individual members, and admonishing the finance ministers of
leading countries to take measures the ministers find incompatible with
domestic objectives. Such a limited role raises the question of whether
these functions alone justify the existence of such a large institution or
constitute a convincing argument for expanding the IMFs resources.
One current IMF function that should be retained is enforcement of the
rules on exchange restrictions on current transactions and on the use of
multiple exchange rates in the Articles of Agreement. These rules have
their counterpart in the rules of the General Agreement on Tariffs and
Trade (GATT) on trade restrictions and on import subsidies and countervailing duties. Exchange restrictions can be used to accomplish the
same purposes as trade restrictions, and the rules for both should be
monitored and enforced. If the IMF were to be abolished or merged with
the World Bank, one way of preserving its enforcement function would
be to transfer responsibility for enforcement to the World Tr a d e
Organization (WTO).
The IMFs Role in Crisis Prevention

Participants in the Halifax Summit of the G-7 countries in June 1995 proposed a new role for the IMF in dealing with financial crisis prevention
PPB No.24
2/17/99
3:13 PM
Page 25
and emergency assistance. The proposal calls for (1) an early warning system for countries in danger of financial crises, including the publication
of key economic and financial data; (2) policy advice to the governments;
and (3) an emergency financing mechanism that would provide faster
access to Fund arrangements with strong conditionality and large up-front
disbursements in crisis situations (International Monetary Fund 1995).
To finance the new role, the Halifax proposal requested that wealthier
nations double the $28 billion in funding now available to the IMF under
the General Arrangements to Borrowing, or GAB (an agreement between
the IMF and a group of wealthier countries), and suggested that consideration be given to increasing IMF quotas.
The Halifax proposal was initiated by the U.S. government in response
to the Mexican financial crisis of December 1994, which led to the
mobilization of some $50 billion in credits for the Mexican government.
Of this amount, about $20 billion was made available from the U.S.
Treasury Stabilization Fund, a similar amount from the IMF, and the
remainder from other countries. The IMF has responded to financial
crises before, but never with such a large amount for an emergency created by massive private capital outflows.
In appraising the proposed role for the IMF, it is necessary to consider
whether increased IMF surveillance and the requirement that countries
make public all the relevant information on their current financial condition will reduce the incidence of financial crisis. Mexico had been receiving
economic assistance and was being scrutinized by the IMF before the crisis, a
fact that raises the question of whether the IMF can provide an effective
early warning system. The IMF held consultations with Mexico just before
the crisis and there is no evidence that the IMF advised depreciation of the
peso or other changes in Mexicos financial policies (International Monetary
Fund 1994, 81). Moreover, there is a need to assess whether a large aid package is the most beneficial use of public international capital. Private capital
i m p o rts do not necessarily finance productive investment that will
strengthen a countrys balance of payments position. If emergency assistance
is used as it was in the Mexican case, much of it would be used to help the
country meet external debt obligations. Only if the capital outflow were
reversed could the IMF be repaid within a short period, but this is by no
means assured. A case has yet to be made that large financial bailouts are an
optimal use of scarce public international funds.
PPB No.24
2/17/99
3:13 PM
Page 26
A New Allocation of SDRs

Included in the multilateral sources of financial assistance to developing
countries under the jurisdiction of the IMF is the allocation of SDRs
(Bretton Woods Commission 1994b, 16). The managing director strongly
advocates creating more SDRs. One argument is that new IMF members
that missed the most recent allotment should be provided with SDRs. This
argument seems to consider SDRs an entitlement, which should be made
available to the former Soviet countries that recently joined the IMF.
One argument originally backing the creation of SDRs was that a shortage
of international reserves would limit world trade. The argument against
creating additional SDRs is that there is no need for an increase in world
reserves and that it would not promote world trade. The idea that global
reserves may at times be inadequate originated during the early postwar
p e r i od when dollars and gold constituted the bulk of intern a t i o n a l
reserves; however, several major currencies now serve this function and
there is certainly no shortage of convertible currency. In addition, the central banks have negotiated agreements for borrowing large sums from one
another. Shortage of reserves is a problem of individual countries, not of
the world at large. General expansion of SDRs would be a poor form of
foreign aid as they are not targeted to specific purposes or to specific countries in need of assistance. Expanding the total volume of international
liquidity serves no global function and might contribute to world inflation.
Proposals for Changing the Functions and Organization of

the World Bank Group
Although there are a number of proposals for changing the policies and
operations of the World Bank Group, few advocate abolishing it. The
proposed changes fall into three categories. First are recommendations
that the World Bank do more to promote private investment in developing countries. This could be done by reducing its loans to state enterprises
and encouraging privatization of these enterprises. Also, the World Bank
should divert more of its resources to the IFC, since the World Bank is
not permitted to make loans to private entities without a government
guarantee (Bretton Woods Commission 1994b, A1A9 and A21A31).
PPB No.24
2/17/99
3:13 PM
Page 27
Second are proposals that the World Bank expand its social and economic objectives, such as reducing poverty, promoting greater equality of
opportunity, improving health and education, and maintaining the environment. These objectives could be supported through loans to small
farms and business enterprises and wherever possible to nongovernmental cooperative institutions. Also, loans for infrastructure projects should
be provided in a way that reduces income inequality and avoids harm to
the environment. In particular, this means not making loans for multipurpose dams that displace small farmers, impoverish river communities,
and produce highly subsidized power for the urban upper class (Rich
1994, Mikesell and Williams 1992).
A third category of proposal has to do with improving the efficiency of
the World Banks operations. These proposals include eliminating activities that duplicate those of the IMF and improving cooperation and divi sion of labor with other development institutions, such as the regional
development banks and UN agencies (Wapenhans 1994, C289C304).
The World Banks management does not, in general, oppose any of these
proposals and it supports their objectives. The World Banks new president, James D. Wolfensohn, has specifically addressed facilitating private
capital flows to developing countries; making more loans directly to the
poor; increasing resources for education, health, nutrition, and family
planning programs; and avoiding making loans for infrastructure programs
that may damage the environment (Bretton Woods Commission 1995).
The World Banks management would disagree with proposals that it cease
making any loans for large infrastructure projects and that it devote all of
its assistance to poverty reduction and social services (Rich 1994).
Promoting Private Investment

The World Bank is handicapped in making loans to private enterprise by
the provision in its charter requiring that all loans to private entities be
guaranteed by a member government. Private firms are often reluctant to
borrow from the World Bank because to grant the guarantee, the government may impose conditions on the firm. The International Finance
Corporation was organized in 1956 as an affiliate of the World Bank to
overcome this handicap, but it got off to a slow start. Today the IFC is
PPB No.24
2/17/99
3:13 PM
Page 28
the fastest growing of the three independent loan organizations of the

World Bank Group, but as recently as FY 1994 its loans made up only 13
percent of total WBG loans. If the IFCs lending, equity financing, and
loan guarantee capacity is to be expanded, it needs more capital. One
proposal calls for the World Bank to provide additional financing to the
IFC to enable it to expand operations. Another proposal seeks to permit
the IFC to increase its subordinated debt (Bretton Woods Commission
1994b, 28). Both these alternatives could expand IFC operations without
obtaining new general capital from its shareholdersthe major industrial
countries. It might be possible for the World Bank to use its own borrowing capacity to raise funds for loans to the IFC, but this would probably
require an amendment to the Banks Articles of Agreement, a nearimpossible task.
Expanding Social and Economic Objectives

A common criticism of the World Bank is that it has been unsuccessful
in reducing world poverty, a goal it now claims as its major objective.
Conceivably, the World Bank could direct most of its assistance to small
farmers and to creating jobs for the urban unemployed; stop making
loans for natural resource development and irrigation systems that benefit large commercial farmers; and devote more resources to supplying
clean water, health services, sewage disposal, and housing in small villages. The difficulty with this approach is that social welfare cannot
improve unless productivity and national output increase. Improvement
requires more goods and services provided by agriculture, industry, techn o l o g y, and imports. In poor countries social welfare cannot be
improved simply by a transfer of income from the rich to the poor.
Without sufficient power and transportation, there will be little foreign
investment and domestic savers will move their capital abroad. There
must be large-scale irrigation to expand agriculture for both domestic
consumption and export, and there must be new agricultural and industrial technology to make exports competitive. It may well be that the
World Bank does not have the right balance between projects that contribute to social well-being and poverty reduction on the one hand and
productivity and growth on the other, but there is no question that it
cannot promote sustainable development by devoting all its efforts to
the former.
PPB No.24
2/17/99
3:13 PM
Page 29
Probably the most publicized criticism of the World Bank is that it has
financed environmentally destructive projects, such as large dams that
displace poor people, logging operations in tropical forests, livestock
projects that erode the soil, and resettlement projects that destroy
forests and the habitat of indigenous people (Mikesell and Williams
1992). The World Bank has admitted that it has made many environmental mistakes in the past and, over the last several years, has made
considerable progress not only in avoiding those mistakes, but in taking
positive steps to assure a sound environment. Most of its project loans
now are subject to environmental impact assessments and, through its
participation in the Global Environment Facility (GEF), in cooperation with the UN Environment Programme and the UN Development
Programme, it subsidizes investment in projects deemed beneficial to
the global environment.
Some environmentalists argue that the World Bank creates a strong
incentive for developing countries to overexploit their forests and other
natural resources because the external debt created by the loans must be
serviced by expanding natural resource exports (Rich 1994, Pearce et al.
1995); the development lending institutions should therefore stop creating additional developing country indebtedness. To a considerable
d e g ree, this is an argument against development itself rather than
against international lending organizations. All development requires
increased imports of goods and services, which in turn must be paid for
by increased exports, which in the case of poor countries generally take
the form of natural resources. Poor countries need external capital to
supplement their low saving, and both external loans and direct investments increase external liabilities. Developing countries will export
their natural resources whether or not the international banks lend to
them, and it is often more advantageous to have those projects financed
by international development banks, which insist on environmental
standards, than to have the projects designed without such oversight.
An important argument in favor of increasing the resources of both the
World Bank and the IMF is that such funding would enable them to
meet a portion of the enormous demand for capital in the former Soviet
countries and those countries that came under Soviet control after
World War II. Unlike developing countries, which have a tradition of
private enterprise, commodity and financial markets, pro p e rty and
PPB No.24
2/17/99
3:13 PM
Page 30
transactions law, and a commercial credit system, the former Soviet

countries need to develop all of the elements that define a modern capitalist economy. Private firms that operate in competitive markets, service
debt, attract private capital, and earn profits must be created, often from
former state-owned enterprises.
The first task of an external lending institution would be to provide
advice and technical assistance for creating an institutional and policy
e n v i ronment in which a capitalist enterprise could operate. Loans
should be conditional on performance in changing the economic and
political structure of the economy. This is difficult for an international
agency. It is easier for the World Bank to tell Bolivia or Kenya to stop
controlling prices or reduce fiscal deficits as a condition for a loan than
it is to impose such conditions on Russia for a large loan. A large loan
to Russia has political significance, both internally and externally,
because of its possible effects on the strategic interests of the leading
Western powers. Because of this significance, the lending standards of
multilateral institutions may well be compromised. Both the World
Bank and the IMF have been criticized as being either too tough or too
soft in imposing conditions on loans to Eastern Europe. Therefore, an
argument can be made that transition assistance to the countries of the
former Soviet Union should take the form of either direct assistance
from Western countries or assistance through the European Bank for
Reconstruction and Development, which was specifically created to
assist these countries. In discussing this question, Kalman Mizsei
(1994) observed, While it is obviously true that there is good cause to
treat Russia differently (i.e., because it is a country that has the military capability to destroy the world), if Western governments decide
that Russia should be treated preferentially, the necessary funds for
Russia should come from those governments directly.
Improving Efficiency of Operations

Several proposals have been made for improving the World Banks
e fficiency: eliminate activities that duplicate those of the IMF,
improve cooperation and division of labor with other development
institutions, and determine if certain existing World Bank activities
exceed their mandate.
PPB No.24
2/17/99
3:13 PM
Page 31
The World Bank makes loans with IDA funds for much the same purposes as it makes loans from its own resources, which means that most of
the criticisms of World Bank operations and loan priorities apply to the
IDA. Special criticisms of the IDA relate to the generous terms on
which assistance is made available. IDA credits have a 50-year maturity,
with repayments required no earlier than 10 years after the loan has been
made. No interest is charged, but there is a 0.75 percent administration
fee. Given these terms, IDA loans (based on a 12 percent rate of discount) are nearly 90 percent grants. Only the poorest countries are eligible for IDA loans, as eligibility is based on per capita income. It may be
argued that since any capital investment should yield a return at least
equal to the cost of borrowing, foreign aid that is virtually a grant is
likely to be used to finance low-yield projects and, therefore, may constitute a misallocation of resources. Countering this position is the argument that poor countries need social projects that will yield positive
returns from higher productivity only after a long period of time; therefore, these projects should be financed by the IDA or by outright grants.
Critics have argued that the IMF and the World Bank should not both be
engaged in providing financial assistance to developing countries. IMF
officials insist that SAFs do not constitute development aid because such
financing promotes balance of payments adjustments that are compatible
with development objectives. This argument is largely semantic. While
the conditions attached to the IMFs SAFs tend to emphasize monetary,
fiscal, and exchange rate policies and the World Banks structural adjustment loans give greater emphasis to the allocation of capital among economic sectors, both institutions seek to realize development objectives
that require a combination of governmental policies and initiatives.
Not only is there considerable overlap between the IMF and the World
Bank in these development operations, but a few cases of actual conflict
have been documented.10 As stated by Gustav Ranis (1994, C75), the
Bank used to concentrate on projects, leaving balance of payments issues
and related macro advice to the IMF . . . it has lately become increasingly
difficult to tell the difference between the two institutions. According to
George Schultz (1995, 56), the overlapping activities of the Bank and
Fund, a change in the traditional mission of the IMF, and the need to use
scarce resources carefully all argue for a merger of these institutions.
Schultz would transfer the functions of the IMF to the World Bank.
PPB No.24
2/17/99
3:13 PM
Page 32
The Bretton Woods Commission report rigorously opposes merging the

institutions on the grounds that the IMF can provide unique services to
developing countries (Polak 1994). Nevertheless, the report recognizes
the need for a more clearly defined division of labor. The report recommends that the IMF focus squarely on short-term macroeconomic stabilization and the Bank should not duplicate the Funds macroeconomic
analysis, but should rely on it in its program planning and project design.
The IMF, in turn, should depend on the WBG to provide financial and
technical assistance to the recipient countries to mitigate the impact of
macroeconomic adjustment on the poor and the environment. The
commission was concerned that duplication of effort could become a
serious problem when a countrys financial imbalance is structural and,
therefore, longer term in nature. In these cases, the IMF should not
pursue independent programs, but its macroeconomic advice should
become part of a longer-term adjustment strategy led by the WBG
(Bretton Woods Commission 1994b, B19).
A complete merger of the IMF with the WBG would require either redrafting the charters of both institutions or terminating the IMF and restructuring the World Bank. Approval by the legislative bodies of member
countries would be extremely difficult to obtain.11 The easiest way to
accomplish a merger of their current activities would be to bring the IMF
into the WBG as a separate entity, similar to the IFC. Integrating the IMF
and WBG could be accomplished by having a single set of executive directors for the IMF and the World Bank. The task of integrating research staffs
and administrative bureaucracies could be left to the executive board, but
the sources of funds for the IMF and the World Bank could remain as stated
in their charters. Such a merger could be accomplished by a simple amendment to the charters and without comprehensive redrafting.
Since the objective of the World Bank and the IDA is to help all developing countries become developed, they should eventually go out of
business. Rupert Pennant-Rea, deputy governor of the Bank of England,
recently stated, In applauding much of what the Bank has done in its
fifty years, I add the hope that it will not live for another fifty years
because it wont need to (Bretton Woods Commission 1994a, 46).
One way of reducing financial assistance from the World Bank and the
IDA is to graduate members who are currently receiving loans.
PPB No.24
2/17/99
3:13 PM
Page 33
Considering that the IDA has never been regarded as a permanent

arrangement but, rather, was designed to help the poorest countries
achieve a condition of positive growth, indefinite dependence on IDA
funds suggests a failure of the program. Graduated countries could still
receive World Bank loans for a time, but that form of assistance also
would eventually be cut off. A number of countries, for example, Korea
and Taiwan, no longer receive loans from the World Bank, and the number of countries eligible for World Bank loans could be re d u c e d .
However, downsizing the World Bank raises questions about the distribution of assistance; that is, if a downsized World Bank provides substantial
financing to Eastern Europe, it may have little left to lend to developing
countries.
Conclusions
My conclusions on the proposals for reforming the Bretton Woods institutions cannot be stated with unequivocal conviction or passion. The
issues are too complex, the arguments in favor of opposing positions too
persuasive, and the reputations of those holding conflicting views too
impressive. Most financial specialists who have considered the future of
the WBG and the IMF accept the principle that there should be multilateral institutions to promote world trade and reduce world poverty
(see, for example, Kenen 1994b). The Bretton Woods institutions, the
WTO, and the GATT are the principal institutions created for these
purposes. Given the large financial resources and the highly competent
staffs of the IMF and the World Bank, they should be doing a better job
promoting trade and reducing poverty. To this end, I propose the following changes in their policies, structure, and operations.
1.
The WBG and the IMF should be merged, with each executive
director (currently there are 24 for the World Bank and 23 for the
IMF) serving as an executive director for both institutions.
I suggest that the new organization be called the World Bank and Fund
Group (WBFG) to preserve the identity of the two major institutions.
The WBFG would also include IDA, IFC, and MIGA. Nothing in
the charters of either institution would prohibit such a change. The
chair of the joint board would serve as the CEO of the combined
PPB No.24
2/17/99
3:13 PM
Page 34
organizations and would be responsible for coordinating their activities. (The members of the boards of governors of the World Bank and
the IMF, who are in most cases the ministers of finance of the member
countries, have always served as governors for both institutions.) Since
both the World Bank and the IMF would still operate in accordance
with their respective charters, it would not be necessary to renegotiate
the Articles of Agreement. The financial accounts of each organization would be kept separately and all financial transactions would be in
accordance with the charters of the individual organizations. The staffs
of the two organizations would be completely integrated, although paid
from different sources. The president of the World Bank, the managing
director of the IMF, and the chair of the joint board would serve as the
g o v e rning council. Responsibility for enforcing the IMFs rules on
exchange restrictions and multiple exchange rates would be given to
the WTO.
2. The IMF should not be given the responsibility for establishing and
managing an exchange rate target zone system or for stabilizing the
exchange rates of the major currencies.
Proposed changes in the international monetary system involving multilateral control over the exchange rates of the major countries are unlikely to succeed for three reasons. First, it is unlikely that the IMF or
any other agency would be able to determine a pattern of FEERs that
would be consistent with a given pattern of current account balance tar gets. Second, it is unlikely that any set of procedure and policy guidelines could maintain market exchange rates in reasonable proximity to a
pattern of exchange rate targets without frequent changes in the pattern
or without very large commitments of reserves for intervention in the
exchange markets. Third, it is highly unlikely that the major countries
could agree on a pattern of target exchange rates or adopt the policies
necessary to control market rates when these policies were not in accord
with their domestic objectives.
Moreover, even if an acceptable pattern of rates could be established,
the IMF would not be the appropriate institution to enforce that pattern. First, the IMF has little or no influence over the policies of the
major powers and should not be asked by the G-7 countries to undertake responsibility for creating an international monetary system that
PPB No.24
2/17/99
3:13 PM
Page 35
the G-7 countries themselves have thus far been unable to establish.
Second, coordination of monetary and fiscal policies for achieving
exchange rate objectives is not possible for sovereign nations, except
perhaps for those forming an economic and political union.
3.
The establishment of a special IMF facility to deal with financial

crises should be deferred.
I have reservations regarding the special facility proposed at the Halifax

Summit for assisting countries experiencing financial crises. The IMF
a l ready has the authority to assist countries experiencing financial
shocks from whatever source, but it should not devote large amounts of
its resources for crises engendered by capital flight. Free capital markets
inevitably involve risks to both creditors and debtors; efforts to lessen
these risks with public international funds may result in the unproductive use of scarce resources.
4.
Development success has been shown to be closely associated with

private investment. Therefore, the WBG should move rapidly to
change the composition of its lending by making fewer loans to governments and state enterprises and increasing its loans to the private
sector, including nongovernmental, nonprofit entities.
The World Bank should increase the proportion of its profits invested in
the IFC. The capital of the IFC should be increased, either by additional
subscription or by arrangements under which the World Bank would
borrow funds from the market to relend to the IFC.
5.
There should be a gradual downsizing of the WBG by reducing the

number of countries eligible for loans.
As countries reach a path of sustained development, they should no

longer be receiving multilateral financial assistance. Also, the United
States and other governments are more likely to reduce than to
increase their contributions to multilateral development organizations
in the future. Therefore, the number of countries eligible for WBG
loans should be decreased. IDA replenishments should be gradually
reduced, working toward eliminating the IDA within the next couple
of decades.
PPB No.24
2/17/99
3:13 PM
Page 36
A possible constraint on reducing (or not increasing) the resources of the

World Bank is the role the WBG is expected to play in the transition of
the former Soviet bloc countries to capitalism. This financial constraint
poses a political question that ought to be faced by the G-7 countries. In
my view, financial assistance for the transition should be provided by the
major Western powers and the European Bank for Reconstruction and
Development. Financial assistance from the WBG should be delayed
until these countries have achieved political and economic stability and
have acquired the institutions, markets, and degree of privatization that
would define them as functioning private market economies.
Acknowledgment
The author acknowledges the valuable contribution made by Henry
Goldstein, professor of economics, University of Oregon.
Notes
1. The Washington, D.C., conference was sponsored by the Bretton Wo od s
Commission and was held at the U.S. Department of State on July 2022,
1994. A conference sponsored by the Institute for Agriculture and Trade
Policy was held at the Mt. Washington Hotel in Bretton Woods on October
1517, 1994. Madrid was the site of the annual meeting of the Board of
Governors of the IMF and the World Bank in October 1994.
2. The IMF par value system required each member to define the par value of
its currency in terms of gold or of the U.S. dollar in terms of the gold content
in effect in July 1944 (1/35 of an ounce). Members agreed to maintain their
exchange rates within a range of 1 percent above and below parity.
3. SDRs are allocated to the members of the IMF in accordance with an amendment to the Articles of Agreement in May 1968. An IMF member wanting
to acquire the currency of another member may transfer SDRs to that member in exchange for that members currency. Each member has an obligation
to accept SDRs up to an amount equal to twice its own SDR allocation.
Normally, only developing countries use SDRs to obtain convertible currencies. The first allocation of 9.5 billion SDRs was made over a three-year
period starting January 1, 1970, and the second over a three-year period starting in 1979, for a cumulative total of 21.4 billion SDRs. As of May 1995, one
SDR = $1.47.
4. For a review of alternative exchange rate arrangements, see Frankel (1994, Ch. 5).
5. The current account includes services and investment income as well as trade.
PPB No.24
2/17/99
3:13 PM
Page 37

6. Taxes are not included because taxes are transfer payments that are not a part
of output. Taxes (T) tend to reduce both C and I. If G increases while T
remains constant, C + I will not decrease to offset the increase in G and,
therefore, CA will decrease or perhaps become negative. If G is greater than
T, there is a budget deficit, G T. The larger the budget deficit, the lower
(or more negative) CA will become, unless there is an increase in Y.
7. In November 1977 the Fed and Treasury Department launched a massive
program to reverse the sharp decline in the dollar with a combination of foreign exchange intervention and credit restraint (in the form of an increase in
the discount rate). This action, however, was not necessarily at variance with
President Carters antiinflationary program underway at the time (Mikesell
1995, 1819).
8. FEERs are not, strictly speaking, equilibrium rates, but are as close to equilibrium rates as can be surmised, given that the other, specified conditions are met.
9. The Council of Economic Advisers (1984) estimated that the dollar was
overvalued by more than 30 percent. This view was rejected by the Treasury
Department, whose officials believed that a strong dollar was desirable and
that a U.S. trade deficit was not a problem to be concerned about.
10. In 1988 the World Bank announced a $1.25 billion loan package for Argentina
at the same time it was known that the IMF considered the countrys policies
inadequate for a new standby arrangement with the IMF (Polak 1994, C153).
11. To gain legislative approval would require opening the Articles of Agreement
of both institutions to change by the legislative bodies of member countries.
This could result in demands for further changes and, in the case of the
present U.S. Congress, a possible move to abolish both institutions.
References
Bergsten, C. Fred, and John Williamson. 1994. Is the Time Right for Target
Zones or the Blueprint? In Bretton Woods: Looking to the Future, Commission
Report. Washington, D.C.: Bretton Woods Commission.
Black, Stanley W. 1994. Effectiveness of the International Monetary Fund.
Bretton Woods: Looking to the Future, Commission Report. Washington, D.C.:
Bretton Woods Commission.
B retton Wo ods Commission. 1994a. B retton Woods: Looking to the Future,
Conference Proceedings. Washington, D.C.: Bretton Woods Commission.
. 1994b. B retton Woods: Looking to the Future, Commission Report .
Washington, D.C.: Bretton Woods Commission.
. 1995. Newsletter, July.
Cooper, Richard N. 1994. Comment. In Peter B. Kenen, ed. Managing the
World Economy: Fifty Years After Bretton Woods. Washington, D.C.: Institute
for International Economics.
PPB No.24
2/17/99
3:13 PM
Page 38

Council of Economic Advisers. 1984. The Economic Report of the President.
Washington, D.C.: U.S. Government Printing Office.
E i c h e n g reen, Barry. 1995. I n t e rnational Monetary Arrangements for the 21st
Century. Washington, D.C.: Brookings Institution.
Federal Reserve Bank of New York. 1995. Treasury and Federal Reserve Foreign
Exchange Operations, January-March 1995. May.
Frankel, Jeffrey A. 1994. Exchange Rate Policy. In Martin Feldstein, ed.
American Economic Policy in the 1980s. Chicago: University of Chicago Press.
Friedman, Milton. 1953. The Case for Flexible Exchange Rates. Essays in
Positive Economics. Chicago: University of Chicago Press.
Humpage, Owen F. 1993. Intervention and the Dollars Decline. Economic
Review 24 (2d quarter), Federal Reserve Bank of Cleveland.
International Monetary Fund. 1946. Articles of Agreement of the International
Monetary Fund. Washington, D.C.: International Monetary Fund.
. 1994. Annual Report. Washington, D.C.: International Monetary Fund.
. 1995. Halifax Summit Communique. Washington, D.C.: International
Monetary Fund.
Kenen, Peter B. 1994a. Ways to Reform Exchange Rate Arrangements. Princeton,
N.J.: International Finance Section, Princeton University.
, ed. 1994b. Managing the World Economy: Fifty Years After Bretton Woods.
Washington, D.C.: Institute for International Economics.
Krugman, Paul R. 1990. Equilibrium Exchange Rates. In William H. Branson,
Jacob A. Frenkel, and Morris Goldstein, eds. International Policy Coordination
and Exchange Rate Fluctuations. Chicago: University of Chicago Press.
. 1991. Currencies and Crises, Cambridge, Mass.: MIT Press.
Mikesell, Raymond F. 1994. The Bretton Woods Debates: A Memoir. Essays in
I n t e rnational Finance No. 192. Princeton, N.J.: International Finance
Section, Princeton University.
. 1995. Proposals for Changing the Functions of the Intern a t i o n a l
M o n e t a ry Fund (IMF). The Jerome Levy Economics Institute of Bard
College, Working Paper no. 151, December.
Mikesell, Raymond F., and Larry Williams. 1992. The International Banks and the
Environment. San Francisco: Sierra Books.
Mizsei, Kalman. 1994. The Role of the Bretton Woods Institutions in the
Tr a n s f o rming Economies. In B retton Woods: Looking to the Future ,
Commission Report. Washington, D.C.: Bretton Woods Commission.
Nurkse, Ragnar. 1944. International Currency Experience. Geneva: League of Nations.
PPB No.24
2/17/99
3:13 PM
Page 39

Obstfeld, Maurice. 1990. The Effectiveness of Foreign-Exchange Intervention:
Recent Experience, 19851988. In William H. Branson, Jacob A. Frenkel,
and Morris Goldstein, eds. International Policy Coordination and Exchange Rate
Fluctuations. Chicago: University of Chicago Press.
Ohta, Takeshi. 1994. The Overlapping Roles of the IMF and the World Bank
G roup. B r etton Woods: Looking to the Future, Commission Report .
Pearce, David, Neil Adger, David Maddison, and Dominic Moran. 1995. Debt
and the Environment. Scientific American, June, 5256.
Polak, Jacques J. 1994. The World Bank and the IMF: The Future of Their
Coexistence. Bretton Woods: Looking to the Future, Commission Report.
Ranis, Gustav. 1994. Defining the Mission of the World Bank Group. Bretton
Woods: Looking to the Future, Commission Report. Washington, D.C.: Bretton
Woods Commission.
Rich, Bruce. 1994. M o rtgaging the Earth: The World Bank, Enviro n m e n t a l
Impoverishment, and the Crisis of Development. Boston: Beacon Press.
Schultz, George P. 1995. Economics in Action: Ideas, Institutions, Policies.
American Economic Review, May.
Wapenhans, Willi A. 1994. Efficiency and Effectiveness: Is the World Bank Group
Well Prepared for the Task Ahead? Bretton Woods: Looking to the Future,
Conference Proceedings. Washington, D.C.: Bretton Woods Commission.
Williamson, John, and C. Randall Henning. 1994. Managing the Monetary
System. In Peter B. Kenen, ed. Managing the World Economy: Fifty Years After
Bretton Woods. Washington, D.C.: Institute for International Economics.
Williamson, John, and Marcus H. Miller. 1987. Targets and Indicators: A Blueprint
for the International Coordination of Economic Policies. Washington, D.C.:
Institute for International Economics.
PPB No.24
2/17/99
3:13 PM
Page 40
About the Author

Raymond F. Mikesell is a professor of economics at the University of
Oregon. Mikesell, a participant at the original Bretton Woods meetings,
has served as a consultant to the World Bank, the U.S. Department of
State, the U.S. Department of Energy, and the United Nations Centre
for Natural Resources, Energy, and Transport. He currently is on the editorial board of the Journal of Resource Management and Technology, and
he also has served on the editorial boards of the Journal of International
Business and the American Economic Review. Mikesells research encompasses the fields of international trade, international finance and foreign
exchange, and environmental and resource economics. His recent publications include Limits to Growth: A Reappraisal, in Resources Policy;
The Bretton Woods Debates: A Memoir (Princeton, N.J.: Princeton
University Press); GATT Trade Rules and the Environment, in
C o n t e m p o r a ry Policy Issues; and Economic Development and the
Environment (London: Mansell). Mikesell received a Ph.D. in economics from Ohio State University.

Mikesell Revising Bretton Woods 1996

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Mikesell Revising Bretton Woods 1996

Uploaded by

Copyright:

Available Formats

PPB No.

The Jerome Levy Economics Institute of Bard College

Public Policy Brief

Proposals for Reforming the International

The Jerome Levy Economics Institute of Bard

Editor: Sanjay Mongia

The Jerome Levy Economics Institute of Bard College 7

Revisiting Bretton Woods

Proposals for Reforming the

The Jerome Levy Economics Institute of Bard College 9

Revisiting Bretton Woods

The World Financial System after Bretton Woods

Proposals for Reforming the International Monetary Institutions

Revisiting Bretton Woods

Alternative International Monetary Systems

Managed Versus Floating Exchange Rates

Proposals for Reforming the International Monetary Institutions

and currency speculation. Freely fluctuating rates, with no attempt on the

Revisiting Bretton Woods

will affect the trade balance by changing the relationship between

Proposals for Reforming the International Monetary Institutions

Revisiting Bretton Woods

Instruments for Managing Exchange Rates

16 Public Policy Brief

Proposals for Reforming the International Monetary Institutions

York (1995), The dollar met aggressive selling by market participants

International Coordination to Manage Exchange Rates

The Jerome Levy Economics Institute of Bard College 17

Revisiting Bretton Woods

compromise their domestic objectives by such coordination. Are the

Proposals for Changing the Functions and Organization

Traditional Role of the IMF

18 Public Policy Brief

Proposals for Reforming the International Monetary Institutions

countries would probably default on their repurchase agreements to the

The Jerome Levy Economics Institute of Bard College 19

Revisiting Bretton Woods

Exchange Rate Management as a Multilateral Effort

The IMFs Role in a New International Monetary System

Proposals for Reforming the International Monetary Institutions

Revisiting Bretton Woods

Proposals for Reforming the International Monetary Institutions

about either multilateral coordination or a dominant role for the IMF in

Revisiting Bretton Woods

exchange rates through policy coordination or convergence is not possible.

The IMFs Role in Crisis Prevention

Proposals for Reforming the International Monetary Institutions

Revisiting Bretton Woods

A New Allocation of SDRs

Proposals for Changing the Functions and Organization of

Proposals for Reforming the International Monetary Institutions

Promoting Private Investment

Revisiting Bretton Woods

the fastest growing of the three independent loan organizations of the

Expanding Social and Economic Objectives

28 Public Policy Brief

Proposals for Reforming the International Monetary Institutions

Revisiting Bretton Woods

transactions law, and a commercial credit system, the former Soviet

Improving Efficiency of Operations

Proposals for Reforming the International Monetary Institutions

Revisiting Bretton Woods

The Bretton Woods Commission report rigorously opposes merging the

Proposals for Reforming the International Monetary Institutions